US real estate total returns fall in Q4 2016
The National Council of Real Estate Investment Fiduciaries (NCREIF) has released fourth quarter 2016 results for the NCREIF Property Index (NPI). The NPI reflects investment performance for 7,364 commercial properties, totaling $525.3 billion of market value.
The quarterly NPI total return has moderated for two years as the real estate cycle has matured. The total return was 1.73% in the fourth quarter 2016, down from 1.77% last quarter and 2.91% in the fourth quarter 2016. The fourth quarter 2016 total return consisted of a 1.14% income return and 0.59% appreciation. The income return has trended lower through most of this cycle with property values rising faster than income as the recovery began, followed by slower quarterly income gains as fundamentals stabilized. Appreciation experienced a steeper downward trend in 2016 with three consecutive quarters of sub-1% appreciation and a fourth quarter capital return at one-third of the rate returned in the same quarter a year ago.
The 2016 annual NPI total return was 7.97% and consisted of a 4.74% income return and 3.10% appreciation. For longer-term context, the annualized average total return for the past five years was 10.92% and 6.93% over the past decade.
Total Returns by Asset Class
The NPI is an unlevered index and low interest rates have provided the opportunity for higher returns by utilizing leverage. For the 3,686 NPI properties utilizing leverage, the leveraged total return was 2.28% in the fourth quarter 2016 and 10.81% for the year, comparing more favorably to other asset classes.
Industrial maintained its lead for quarterly (3.04%) and annual (12.31%) total returns with other property types trailing by a wide margin. Industrial was the only property type to outpace the overall NPI for the quarter and had the only double-digit annual total return in 2016. Apartment and retail had similar quarterly total returns, while retail outperformed apartment and the overall NPI for the year. Office experienced marginally positive appreciation in the second half of 2016 for a 6.20% annual total return. Hotels had quarterly depreciation throughout 2016 to remain the weakest property type with total returns of 0.67% in the fourth quarter and 4.71% in 2016.
NPI Total Returns by Property Type
Property fundamentals are healthy at the end of 2016. Occupancy remains at its 15-year high of 93.2%, which is up 40 basis points (bps) from fourth quarter 2015, and net operating income (NOI) growth was 5.3% (including hotels) for the year. Although occupancy was steady overall, there was considerable variance by property type. Occupancy was up for industrial and office over the quarter and the year, but down for apartment and retail. With a 90 bps increase over the year, to 96.1%, industrial occupancy remains the highest of all property types, while office, at 88.8%, remains the lowest despite the same annual increase in occupancy. Industrial took over the lead for annual NOI growth, at 7.4%, followed closely by apartment at 7.0%. Office NOI growth closely tracked the overall NPI, at 5.0% and retail had 2.6% NOI growth in 2016.
With 241 properties traded, transaction volume for NPI properties totaled $14.0 billion in the fourth quarter 2016, for a 24% increase in volume over the same quarter a year ago. Transaction volume in 2016, at $40.2 billion in 805 properties, was up 23% from 2015. Cap rate compression continued with the implied valuation cap rate at 4.43% in the fourth quarter 2016, setting yet another historical low. Cap rates are sub-5% for all property types, ranging from a low of 4.17% for office to a high of 4.92% for industrial.